Arch Coal Inc (ACI), Peabody Energy Corporation (BTU): Will Coal Make a Comeback in 2013?

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Natural gas prices rising

The relation between natural gas and coal is very straightforward: As the price of natural gas rises, the price of coal follows. Moreover, during 2012 and 2013 the linear correlation between changes in coal and natural gas prices (average monthly prices) was strong and positive at 0.35. I think the relation between natural gas and coal is such that the natural gas market affects the coal market, because natural gas isn’t only used for electricity.

The electricity industry accounts for 39% of the natural gas used in the U.S for consumption in 2012; 30% for the industrial sector; and 30% for the residential/commercial sectors. These two last sectors are affected by the weather, because they include usage of natural gas for heating purposes. So the price of natural gas is affected by the fluctuations in demand in industrial, electric and residential/commercial sectors. On the other hand, nearly 90% of coal is used for generating electricity at power plants. So coal, unlike natural gas, is less affected by other sectors. This means that natural gas is plausibly leading the way in the relationship between coal and natural gas.

The recent rally of natural gas prices is likely to curb the demand for natural gas in the electricity sector. This, in turn, is likely to pull up the demand for coal, which will pressure up the price of coal. The chart below shows the developments of coal and natural gas prices during 2012 and 2013.

The rise in natural gas prices during the first few months of 2013 is likely to raise the demand for coal in the electricity industry. If the demand for coal rises, if production changes course, if the price of natural gas continues to rise, then the coal industry will recover and coal mining companies will rally.

The article Will Coal Make a Comeback in 2013? originally appeared on Fool.com and is written by Lior Cohen.

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